Schaeffer's Trading Floor Blog

Potential Warning Signs from VIX-Land

'Too many bets in one direction can't end well'

by 2/11/2014 7:27 AM
Stocks quoted in this article:

The market sure looks better now than it did just a few days ago. But there are some warning signs in CBOE Volatility Index (VIX)-land, if you're into contra-tells. This, from Bloomberg's "Options Beat":

Ownership of puts on the Chicago Board Options Exchange Volatility Index reached a record 3.2 million on Feb. 6, according to data compiled by Bloomberg. Money poured into the bets against the VIX (VIX) after the gauge, used by investors as insurance against share losses because it rises when equities fall, climbed to a 13-month high of 21.44 last week before collapsing to 15.29 by Feb. 7.

Mind you, call ownership still dwarfs put ownership in VIX. Open interest on Feb. 6 was 7.2 million as per the same piece. Of course, you have to put it into VIX context and the lion's share of volume and open interest always tilts towards calls. And puts comprising about 30% of the open interest is a reasonably high reading.

But wait, there's more:

Bets on a decline in volatility also pushed record money into an exchange-traded note that rises in value as stock-market swings narrow. Assets in the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) doubled over the past two weeks to $810 million on Feb. 7, according to data compiled by Bloomberg…

…It's the first time that the inverse VIX note has surpassed assets in the iPath S&P 500 VIX Short-Term Futures ETN (VXX), which trades under the ticker VXX and gains when stock fluctuations widen. The iPath security lost as much as 37 percent of the money invested since Jan. 24, pushing its market value to a two-year low of about $745 million on Feb. 6, while its shares retreated 16 percent to $45.46 since Feb. 5.

I'm a small XIV holder as I type. I bought too early, than I bought OK, then sold some back out, and it's all about a scratch around here.

On the margins, it's just not a great sign that there's so much interest in fading the VIX rally. But having said that, the last few years have taught everyone that volatility is pretty dormant. It perks up about three or four times a year, but those pops mostly fade in short order. So it's understandable that the inclination is to assume this time will be no different. Hey, it hooked me in a little bit.

It obviously won't work forever. We're not done with this move quite yet, as we can't rule out that it's the beginning of a longer-term lift in volatility. If VIX does continue to drift, as per the norm, and all that VIX put buying and XIV buying "works," it further internalizes the lesson that all VIX pops are fades. And the bets against VIX will get even bigger the next go around. And that's ultimately very dangerous, in my humble opinion. Too many bets in one direction can't end well.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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